When the May futures contract of the benchmark WTI (West Texas Intermediate) crashed into a negative territory for the first time in history on April 20, many thought the Indian oil sector would be a natural beneficiary. For a country like India, which imports 85% of its energy requirements, that’s logical thinking. But keep the rationale for normal times. For, the realities of an economy under a national lockdown are quite different.
The precipitous fall in the global crude-oil prices is actually a double whammy for Indian oil companies involved in refining and retailing, and exploration and production (E&P).
Under normal circumstances, the upstream companies are hit the hardest when the crude prices fall, while the downstream companies relish the profits. But this time around, even the downstream companies are walking on the thin ice.
ET Prime spoke to officials of both upstream and downstream companies and experts to analyse how the current upheaval in the global oil market will play out in India. They were unanimous that the oil marketers would be encumbered by margin squeeze and heavy inventory losses, while players in the E&P space will be hit by lower realisation per barrel.
Oil’s there. But who’ll buy?
Normally, Indian downstream or oil-marketing companies (OMCs) make good money when crude-oil prices show a downward trend. The benefits come in multiple ways – the marketing margins improve, the loss on selling fuel comes down, discounts from oil-producing nations go up. A benign crude means lower working capital and higher profits.
But this time around, the lockdown has added a dirty twist to the tale.
There has been a significant drop in demand and senior officials of Indian Oil Corporation (IOC) say retail sales have slipped more than 50% since the beginning of the year till the second week of April compared with the same period a year ago . Diesel sales are down 61%, while petrol and aviation turbine fuel (ATF) sales have declined by 64% and 94%, respectively.
Due to these uncertain times, OMCs had to shut their refining plants and lower their capacity. IOC and Mangalore Refinery and Petrochemicals (MRPL) have declared force majeure. MRPL is in the process of shutting down its entire plant. “MRPL had reduced runs by up to 40% and closed its Panipat naphtha-cracker plant because of sliding petrochemicals demand,” an IOC official tells ET Prime. MRPL is a subsidiary of Oil and Natural Gas Corporation (ONGC) and IOC.
BN Bankapur, former head of refineries at India Oil Corporation, says, “This is the first time ever that refineries in India are running at such low capacity of 25%-30%. Shutting down refineries is a very big challenge and costs of running it up increases significantly. Unless demand improves, things are not well for refiners.”
BK Namdeo, former director – refineries at HPCL, says, “It’s not safe to operate refineries at such low capacity. Running refineries at 30% capacity might damage the equipment.”
Since January 2020 , the spread for gas-oil has declined by USD1.9 per barrel from USD12.8 per barrel to USD10.9 per barrel. This will negatively impact gross-refining margins (GRM) of the downstream companies on a quarterly basis. Quarterly decline in product spreads for petrol by USD8.7 per barrel from USD15.8 per barrel to USD6.8 per barrel, and for ATF by USD6 per barrel from USD14.7 per barrel to USD8.7 per barrel has brought down GRMs.
With demand coming to a standstill due to the lockdown, OMCs are likely to book heavy inventory losses during the March and subsequent quarters of 2020, even with positive GRMs. The immediate negative impact of inventory losses will be reported in the March and June quarter numbers. But once the lockdown ends, subsequent quarters should see better numbers, as refiners’ interest cost on capital borrowing would ease. The internal fuel costs will also go down.
According to a senior oil-industry analyst, the OMCs are likely to see inventory loss of more than USD5.6-USD8/barrel in Q4 FY20 given that they bought crude at an average price of USD65-USD67 in the December quarter.
Vidyadhar Ginde, oil and gas analyst at ICICI Securities, says, “If one assumes the average closing price of oil in the third quarter of FY20 at USD67 per barrel, then BPCL inventory losses for, say, 13 days would be around INR3,000 crore. As for IOC, the inventory loss could be more than INR8,000 crore given its inventory level.”
For BPCL, GRMs are likely to crash to USD0.3 per barrel in the last quarter of FY20, compared with USD3.2 per barrel in Q3 on account of inventory losses and lower oil and gasoline spreads. The company could report a net loss at INR556.2 crore for the fourth quarter. For HPCL, another state-run OMC, margins are expected to come down to USD1.5 per barrel against USD1.8 per barrel in Q3FY20. Overall, the company is expected to report a net loss of INR628.4 crore. The largest oil marketer IOC is also expected to report a net loss of INR2,400 crore in Q4.
Yogesh Patil, analyst , Reliance Securities, says for every dollar/barrel fall in crude prices, net marketing margin of OMCs rises by INR0.45 per litre. However, some of these gains may get offset if the government raises duties on retail fuels.
Analysts at Edelweiss estimate that there will be a 12%-21% cut in FY21 estimated EPS (earnings per share) of OMCs. Despite the cut, for FY21 it estimates a 20%-75% earnings growth for the OMCs. The three OMCs – IOC, BPCL, and HPCL — also offer strong dividend yield of more than 6% which makes them attractive investment opportunities.
Oil companies are bleeding worldwide.
Refiners in Japan, South Korea, and Thailand – already running at reduced rates – are looking at more capacity cuts even as they shut plants for maintenance.
In order to contain the steep decline in oil prices, on April 12 , the Organisation of the Petroleum Exporting Countries (OPEC) and its allies agreed to cut 9.7 million barrels a day from the market in May and June. It is a record and equivalent to about 10% of global supply. But crude prices still fell as there was virtually no demand. The International Energy Agency (IEA) expects demand to shrink by 29 million barrels a day this month alone.
Oil companies — from Algeria to West Texas — are slashing their budgets and many are filing for bankruptcy.
According to energy and restructuring law firm Hayes and Boone, as many as 50 energy companies had filed for bankruptcy in 2019. So far in 2020, more than 10 oil companies such as Whiting Petroleum, Skylar Exploration, Echo Energy Partners, Sheridan Holding company, and Dalf Energy have filed for bankruptcy. According to the firm, in the last five years ended April 1, 2020, 215 energy producers have filed for bankruptcy involving more than USD129 billion in aggregate debt.
The energy boom over the past decade had made it easy for oil companies to finance growth with cheap, borrowed money. But the steep fall in oil prices and the Covid-19 pandemic have changed things for worse.
Already under a big pile of debt, many companies are now struggling to make interest payments and grappling to raise new financing, which has become more expensive as traditional buyers of debt have vanished and risks to the oil industry have grown. Companies are increasingly turning to restructuring advisors to find a way out, while the weaker ones are going belly up.
After Monday’s fall in crude futures, the benchmark crude indices, WTI and Brent, fell nearly 70% on Tuesday. At the time of writing this story, WTI was trading at a historic low of USD6.6 per barrel and Brent was at USD17 per barrel.
High cost, low realisation
For the upstream companies in India, a prolonged low crude-oil price scenario will mean a heavy dent on their books.
According an ICRA report, for every dollar per barrel change in crude-oil prices, the revenues and profit before tax of ONGC is impacted by INR1,240 crore and INR860 crore, respectively; for Oil India (OIL) it is INR170 crore and INR120 crore; INR 310 crore and INR230 crore for Cairn; and INR60 crore and INR40 crore, respectively, for Reliance Industries (RIL). The calculation was made considering an INR/USD exchange rate of 70.
Oil-exploration companies such as ONGC, OIL, and RIL are already suffering from low realisations.
Vivek Jain, oil analyst at India Ratings, says, “The profits of upstream companies — ONGC and OIL — could potentially decline 80%-90% in the current fiscal, compared with previous fiscal owing to lower realisation per barrel and sticky lifting and operating cost. The lifting and operating costs (the cost per barrel for extracting oil from the well) of the Indian companies have continued to remain significantly higher even in a low-price environment. On the other hand, the oil explorers globally have been able to cut their operating cost when global oil prices had a southward trajectory.”
In addition, the companies have continued with their large capital expenditure despite a hit in realisation per barrel. Besides, the interest payout of ONGC has doubled in the last three fiscal years. “This is likely to hurt further in times of compressing oil realisation,” Jain adds.
The impact on ONGC and OIL books has been limited so far, as their crude-oil realisations were earlier dampened by large under-recovery sharing burden. ONGC is the country’s largest oil exploration and production (E&P) company and accounts for around 90% of the country’s proven oil and gas reserves.
The stock prices of the upstream oil companies have lost a lot of value on the NSE. In the December quarter, ONGC’s standalone pre-tax profit halved to INR5,999 crore from INR12,063 crore in the same period the previous year. Its shares are down at INR50 from INR250 levels one year ago. There are just no upsides for domestic public-sector oil explorers.
Analysts believe the oil-price crash could put a question mark on an early commencement of RIL’s proposed deal with Saudi Aramco, whose shares are trading below the IPO price. This could delay RIL’s plans to become debt free by 2021. RIL wants to sell prompt crude as it looks to cut output in April and May.
With a decline in the cash-generating ability (due to lower realisations on sale of oil and gas) of their E&P blocks, upstream companies such as ONGC, OIL, Cairn, and RIL have recognised an impairment loss of around INR20,000crore last year.
Besides the impact on profitability, the decline in crude-oil prices and a moderate outlook adversely impacts the viability of new exploration and development projects.
With the low oil-price scenario, upstream companies have undertaken various cost-optimisation measures including re-negotiations with existing contractors for lowering the rental and services cost.
Additionally, private upstream players are scaling down their capital-expenditure programme. The state-run companies are, however, maintaining their exploration and production programmes, though the capex in value terms has reduced owing to the lower cost of oil-field services.
In response to decline in crude oil and gas prices, most global E&P companies have cut their capex plans. Drilling activity has also registered a slowing trend, leading to a decline in the rates for drilling and other oil-field services. The day rates for rigs across various categories have declined 30%-40% globally. Some companies have started to shut their wells, taking a serious hit on their finances.
The bottom line
The pandemic has shaved off oil demand by 30 million barrels a day — the output of the US, Russia, and Saudi Arabia put together. At this moment, there is no clarity on when the demand will revive.
But analysts are optimistic that the oil sector’s fortunes are likely to improve substantially once the world finds its way out of the pandemic. Most analysts expect oil prices to exceed USD40 a barrel in near future. But till then, it will be extremely difficult for any Indian company to establish a credible exploration plan to compete.
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